Saudi Vision 2030 defence spending outlook and BAE Systems opportunities

Defence: Vision 2030 supports defence spending Celine Fornaro >> Benjamin Heelan >> MLI (UK) MLI (UK) [email protected] [email protected] Saudi Arabia is increasing its regional role as a Security and Defence nation in the Middle East region. The 2030 Vision includes a higher local content in defence procurement which can be achieved through new contract awards and increased cooperation with large Original Equipment Manufacturers (OEMs). BAE is best positioned, in our view: it has been the in the country since 1966 with 5,000 local employees and Saudi Arabia represents 21% of BAE’s group sales. Saudi Arabia to build out military industrial base Defence is one of the key industries that Saudi is pinpointing for investment as part of its future strategy plans, and one where it is well placed to become a global leader, in our view. Saudi Arabia has one of the largest defence budgets globally, and we expect its focus on defence investment to remain broadly intact regardless of the price of oil. Due to regional tensions, defence spending will likely remain high for the foreseeable future, in our view. Saudi Vision 2030 and the associated National Transformation Plan (NTP) will likely increase focus on use of defence to achieve their economic diversification goals. This is likely to take place through capability deployment and employment in partnership with long term defence partners. Saudi authorities aim to raise the locally-sourced defence procurement from 2% today to 50% in 2030. Much of the countries’ defence spending is for foreign imports. According to consultancy IHS, 1 out of every 7 dollars spent on defence imports in 2015 was spent by Saudi Arabia, which was predicted by IHS to increase its defence imports by 52%yoy to USS9.8bn in 2015. In our view, Saudi strategy to increase locally manufactured defence content is justified, given their level of purchasing power with international contractors. However, this could trigger a round of new contracts’ awards to set up new terms. The State owned Taqnia company has been signing some contracts with international companies but this remains very limited at this stage. Saudi commitment to defence spending positive for European Defence Saudi Arabia’s Ministry of Finance 2016 defence budget spending remains high at SAR213bn (cUS$57bn) which is 25% of the total budget. In 2015, the budgeted defence spending reached SAR307bn (US$82bn). Despite the large decrease in headline defence and security expenditure, budgetary figures suggest the allocation for the Ministry of Interior, Ministry of National Guard, Ministry of Defence, General Intelligence Directorate, and Saudi Royal Guard Regiment could be heavily supported from elsewhere in the budget, if required. Figures released by the Ministry of Finance suggest that SAR183.0bn of the state budget for 2016 - c21% of total budgeted spending - will be allocated through a new ‘Budget Support Provision’ that is to be used "to give more flexibility to the budget and redirect capital and operational expenditure in line with national priorities and to fulfil spending requirements". In our view, the commitment to defence spending is positive for companies who have presence in the area, BAE (Buy, 600p) & Thales (Buy, €87). BAE Systems ties to Saudi Arabia go as far back as 1966, when the company was contracted to Lightning and Strikemaster aircraft and equipment in a programme called the ‘Magic Carpet’. In 1985, a new government-to-government (UK/Saudi Arabia) agreement was signed covering supply and support of Tornado, Hawk and PC-9 aircraft. A new government-to-government agreement, known as the Saudi British Defence Co- operation Programme, was inaugurated at the start of 2007. Salam Project, which OS Merrill Lynch GEMs Paper #26 | 30 June 2016 75 HOUSE_OVERSIGHT_016185